10 PERCENT OF GDP

April 17, 2008

Congress is disturbed about the bailout risk from the Federal Reserve opening its discount window to borrowing from investment banks and broker-dealers. That's a reasonable concern, says the Wall Street Journal.

Consider:

The Fed already guaranteed $29 billion in dodgy Bear Stearns paper.

But according to S&P, the "maximum potential cost" of bailing out Wall Street would be below 3 percent of gross domestic product (GDP), assuming a deep and prolonged recession.

That's painful, but not catastrophic.

The far greater danger comes from Fannie Mae and Freddie Mac:

The taxpayer risk, combined with that of other government-guaranteed agencies, yields a potential fiscal cost to the government of up to 10 percent of GDP, according to the S&P.

With total U.S. GDP estimated at somewhere north of $14 trillion, that would put the Fan and Fred bailout cost at about $1.4 trillion.

This "fiscal burden" would be so large, in fact, that S&P figures it could even jeopardize the AAA credit rating of the U.S. government.

These are the same two companies, by the way, that have recently had their capital requirements reduced and their jumbo mortgage lending limits increased to a maximum of $729,750. New York Senator Chuck Schumer, among many others on Capitol Hill, had browbeaten the Bush Administration until it eased those limits. Capital is of course the only cushion taxpayers have against a bailout if Fan and Fred keep racking up losses, says the Journal.